Program to bolster mortgage giants

The Washington Post

Published Monday, July 14, 2008

WASHINGTON -- The federal government unveiled a broad program Sunday evening to bolster troubled mortgage giants Fannie Mae and Freddie Mac, extending unprecedented support to the companies and proposing new authority to lend them money and even buy their stock.

Scrambling to announce the initiative before the trading week began, federal officials said they would allow the firms for the first time to borrow money from the Federal Reserve. Officials are also seeking permission from Congress to temporarily increase the amount the companies can borrow from the Treasury and enable the government to invest directly in the firms if conditions worsen.

The two firms, which dominate the market for U.S. mortgages, have been reeling amid investor concern that the companies might not have enough capital to handle their losses due to the rising number of bad home loans. Both firms' stocks plummeted by almost half last week.

Treasury officials said Sunday night that they were confident Congress will be able to pass the new laws they seek by the end of the week as part of a broad housing bill under consideration on Capitol Hill.

In a coordinated action, the Federal Reserve announced that it would allow Fannie Mae and Freddie Mac to borrow money on an emergency basis.

The firms, should they experience a cash crunch, will be able to exchange certain assets for cash at the Fed's discount window, a privilege long enjoyed by commercial banks and extended in March to struggling investment banks.

If Fannie Mae or Freddie Mac collapsed, it could cripple the U.S. housing market, dealing a staggering blow to the wider economy, and would saddle the federal government with massive debts if it chose to seize control of either firm.

"Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies," Treasury Secretary Henry M. Paulson Jr. said in a statement he read before television cameras Monday night. The strength of their debt "is important to maintaining confidence and stability in our financial system and our financial markets," he said.

A failure of either company would also rattle global financial markets because their shares and debt are widely held by pension funds, mutual funds and foreign governments.

Both companies said they were financially sound but were grateful for the confidence-building efforts. The proposals, taken together, make more explicit than ever that the federal governments backs the two federally chartered companies, even though they are investor-owned.

The changes that Treasury plans would expand the amount that Fannie and Freddie could borrow from the government in the event of cash flow problems. Currently, they can each withdraw $2.25 billion. The Treasury secretary could increase that amount at his discretion.

The Treasury secretary would also have the authority to invest government money in the firms by buying their stock, a step that would only be taken if the firms don't have enough capital and are unable to raise it on private markets.

"Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer," Paulson said.

The new measures would give Paulson the authority to provide federal money to the firms after negotiating the conditions with them. Treasury officials stressed that this would allow the government to get the most favorable terms possible for taxpayers, potentially putting existing shareholders in a less favorable position.

"This is a very sweeping proposal," said Bert Ely, a banking expert and longtime critic of Fannie Mae and Freddie Mae. "This plan goes further than I thought they would go and suggests a deeper level of concern about the companies."

The initiative comes after a harried weekend of calls among officials at Treasury, the Federal Reserve and other agencies, and between Washington and Wall Street. Paulson led the creation of the plans, in sessions that went late into Friday and Saturday nights. He and Timothy F. Geithner, president of the Federal Reserve Bank of New York, held extensive conversations with Wall Street executives in preparing the initiative.

The plan aimed in part at heading off further losses of confidence in Fannie Mae and Freddie Mac on global markets and was unveiled shortly before Monday trading opened on stock markets in Asia. The announcement also came on the eve of a crucial sale of $3 billion in securities by Freddie Mac. Federal officials also worked through the weekend to ensure that the sale, a test of investor confidence, would succeed.

Government leaders opted not to inject new money into the firms directly and stopped far short of nationalizing them. Officials continue to state that the companies are financially sound and should be able to continue funding Americans' home mortgages.

A senior Treasury official said that both of his department's proposals the expanded credit line and the authority to make equity investments are envisioned as temporary, expiring after 18 months.

The official said there were extensive discussions with congressional leaders of both parties over the weekend and that "nothing suggests we will not be able to accomplish this." Key members of Congress Sunday night endorsed the Treasury and Fed efforts, though one suggested the measures may not be adopted as quickly at the administration hopes.

Chairman Barney Frank, D-Mass., of the House Financial Services Committee said he expects that the thrust of what Paulson requested will be approved by the House this week and accepted by the Senate next week, allowing President Bush to sign the measure by the end of next week. He added that the plans did not amount to a "bailout." Instead they conveyed that "we don't think there's a terrible problem, but we want to reassure you if there is one, we can deal with it."

Sen. Charles E. Schumer, D-N.Y., who chairs the Joint Economic Committee, also welcomed the plan: "It will be reassuring to investors, bondholders and mortgage-holders that the federal government will be behind these agencies should it be needed. The Treasury's plan is surgical and carefully thought out and will maximize confidence in Fannie and Freddie while minimizing potential costs to U.S. taxpayers."

Another component of the plan is to give the Federal Reserve a "consultative" role in setting the firms' capital requirements. That would enable the Fed, which works to ensure the stability of the financial system, to help set requirements on Fannie and Freddie's finances that might lessen the risks they pose to the broader economy.

The actions mark the most extensive government intervention into the financial world since the Fed rescued Wall Street investment bank Bear Stearns from bankruptcy in March. They are also designed to allow the companies to continue their roles making funding available for Americans to buy homes.

The firms funded about 70 percent of the home mortgages issued in the first three months of the year, but investors fear that the companies do not have enough capital to weather the eventual losses on bad loans on their balance sheets. Freddie Mac's shares have tumbled 88 percent since their high in 2006, and Fannie Mae's stock is off 85 percent since its most recent peak last year.

Separately, the Securities and Exchange Commission announced Sunday that it and other regulators will immediately begin to examine whether securities prices have been manipulated by the intentional spread of false information. This action was timed in part to coincide with the government's announcement about its aid to Fannie Mae and Freddie Mac. Also Sunday, the Federal Deposit Insurance Corp. issued a statement indicating that IndyMac, the failed California-based bank it took over Friday, will reopen Monday with all its functions operating normally.